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Russia Squeezes Out Saudis In Asia Market Share Race

Saudi Arabia is struggling in its key economic and geopolitical ambition to position itself as the key substitute in Asia in general and China in particular for lost Iranian barrels due to re-imposed sanctions by the U.S. The opportunity is huge as, a senior source who works closely with Iran’s Petroleum Ministry exclusively told OilPrice.com last week, Iran as of last week was exporting just 266,000 barrels per day (bpd) of crude oil compared to the 2.5 million bpd exported just before the U.S. withdrew from the nuclear deal last May. Although some of the headline figures appear to offer some scope for Saudi optimism, a look beneath the surface shows the situation is far from rosy, with threats from both U.S. and Russian supplies. Indeed, with the recent scare over contaminated barrels now apparently behind it, Russia is also ramping up its threat against increased U.S. supplies as well, signalling a broader burgeoning relationship with the Asian powerhouse of China.

Specifically, over the January to May period, Saudi state-owned behemoth, Aramco, seemed to hold its own in China, Asia’s biggest oil consumer. According to the latest figures from China’s General Administration of Customs, the country imported 223.858 million barrels of crude oil from Saudi Arabia, up 9.8% from the 203.811 million barrels of a year earlier. It is crucial to note, however, that this positive position was due to the addition of two new independent refinery customers – Zhejiang Petrochemical Co., and Hengli Petrochemical (Dalian). Hengli, with a total capacity of 400,000 barrels per day (bpd), signed a term contract with Aramco in late 2018 to buy 130,000 bpd from it, whilst Zhejiang Petrochemical, also with a 400,000 bpd total capacity, agreed to take 116,000 bpd from Aramco on a term basis. This latter deal coincided with Aramco offering to take a 9% stake in Zhejiang Petrochemical.

Without these two deals, Saudi would again have lost its top crude supplier position for China to Russia, which supplied 220.201 million barrels and held a 14.6% market share in China for the January to May period. A similar – but worse – theme was evident with the other big Asian customers of South Korea and Japan. South Korea bought in 126.648 million barrels of crude oil from Saudi Arabia over the January to May period, a 1.2% drop compared to 128.229 million barrels received in the same period a year ago. Japan, meanwhile, imported around 5.5% less crude from Saudi over the period, a total of 1.169 million bpd.

For Russia, the ongoing OPEC+ production cap deal allows it a lot more flexibility that it allows Saudi Arabia. “Russia sort of produces whatever it wants whenever it wants, according to the dynamics of the oil price not the dynamics of the OPEC+ deal, as it knows that Saudi has to toe the production cap line as an example to the rest of the OPEC producers but Russia merely has to lend its vocal support to the deal to keep Saudis happy, and it [Russia] will effect real cuts if and when the oil price action requires it,” Sam Barden, chief executive officer of global energy trading firm, SBI Markets, in Melbourne told OilPrice.com. “The Kremlin was also the earliest of all the major oil producers – with the exception of the U.S. itself perhaps – to position itself to make up the supply shortfall that was going to be caused by the new U.S. sanctions on Iran, as its ESPO [East Siberia-Pacific Ocean] blend was a very good substitute for the Iran blends in high demand in Asia,” he said.

The strategy to target Asia in general and China in particular was properly put into action after the launch of the East Siberia-Pacific Ocean pipeline in 2010, which allowed much more oil to go directly to Asia, and was given a further boost in January last year with the launch of a second parallel pipeline, which means that China itself can import around 30 million tons of oil (around 600,000 bpd) every year from Russia, Mehrdad Emadi, head of global risk analysis and energy derivatives markets consultancy, Betamatrix, in London, told OilPrice.com. The original idea was that this increase to Asia could be achieved simply by boosting crude oil output in East Siberia but this did not occur as early as was needed, so it was necessary to make some adjustments to crude oil intended for Europe, both in terms of quality and quantity. By the end of 2017, ESPO crude export levels had quadrupled since 2010, to nearly 1.2 million bpd, and are set to increase to around 1.6 million bpd in 2020, according to Russia’s energy ministry. These numbers include long-term deliveries to China via the Skovorodino-Mohe pipeline offshoot from the ESPO trunk network as well as spot cargoes via the port of Kozmino on the Pacific Ocean.

This drive to capture as much of the Asia market – especially that of China – as soon as possible was a key reason for the drop in quality seen in ESPO flows to Europe, even before the recent contamination with Russian crude manifested itself. As early as November 2017, Russian national pipeline monopoly Transneft stated that the sulphur content of Urals oil exports from the Baltic port of Ust-Luga and the Druzhba pipeline running to Europe would increase to a critical level of 1.8% in 2017 – the very edge of the level considered allowable for Urals crude, according to the quality range set by the Russian standards agency Rosstandart – and then would continue to rise, as more low-sulphur crude oil is shipped to China. According to an-end December press release on Transneft’s own website, the sulphur content in Urals produced by Tatneft and Bashneft was more than 2.0-2.3%.

Given these logistical developments and the ever-closer relationship between Russia and China in other energy projects (the mammoth ‘Power of Siberia’ gas pipeline running from Russia into China is 99% complete) and security (Russia was an original founder alongside China of the political, economic, and security alliance, the ‘Shanghai Cooperation Organisation’), it is entirely unsurprising that the vast majority of China’s state-run and independent sectors continue to favour Russia’s ESPO blend. In June, the ESPO blend was the top feedstock crude for China’s independent refineries, with 16.273 million barrels imported, up 33.3% from May’s 12.168 million barrels, according to various independent industry data. This shift back to Russian supplies has also been exacerbated by the worsening security fears attached to doing business with Saudi Arabia in the current geopolitical environment. “Potential buyers are looking at threats from Iran, threats from the Yemeni Houthis launching strikes into Saudi, and attacks in southern Iraq, which is deterring buyers form dealing with Saudi,” the Iran source told OilPrice.com. “China National Petroleum Corporation very recently refused to go ahead with a major term contract with Saudi for this very reason,” he added.

“In addition to the better security profile, the easier general logistics, the voyage times for Russia ESPO are shorter than those for Saudi grades, the lot sizes are more flexible, and it yields more gasoil as well, which is very useful for a lot of these Chinese refiners,” said Betamatrix’s Emadi. “Moreover, Russia is offering term contract deals that are framed in such a way that for a certain amount of crude oil bought by key Asian customers every month for whatever number of years, these customers will also be given the right to buy oil derivatives, including various petrochemical products, at deeply discounted prices,” he concluded.